As currency seizures from Mt. Gox hit nearly $5 million, the fear of instability is driving people away from Bitcoin.

The largest Bitcoin currency exchange is facing a perilous future as U.S. authorities continue to seize its bank accounts.

As GigaOM recently reported, Mt. Gox, the largest Bitcoin exchange by volume, had $2.9 million seized from its Dwolla account (a service similar to PayPal). This past Friday, Bitcoin blog The Genesis Block reported that authorities seized another $2.1 million from the exchange’s US-based bank accounts with Wells Fargo in addition to $50,000 from CEO Mark Karpeles’ personal account.

In June Mt. Gox said it would suspend its U.S. dollar withdrawal feature, only to have it return within two weeks — albeit in a more sluggish fashion as its currency reserves had lessened (it’s facing a similar scenario to a run on the banks).

The U.S government has seized Mt. Gox’s funds because it says the exchange was acting as a money transmitter without a license. Mt. Gox hasn’t publicly commented on the government’s accusations, but it told the press in April that it was in the process of applying for the necessary licenses to be compliant with U.S law.

According to seizure warrants published by The Genesis Book, Karpeles told his financial institution “no” to two key questions when setting up the bank account for Mt. Gox’s American holdings: “Do you deal in or exchange currency for your customer?” and “Does your business accept funds from customers and send the funds based on customers’ instructions (Money Transmitter)?”

Currency Flux

As Mt. Gox’s future as an effective currency exchange lingers in the air, and the day the U.S. government regulations effectively lift the veil of anonymity draw closer, the currency has been in flux with high volatility throughout the summer of 2013.

Consider Bitcoin’s rise to near $200 level in the first place: Cyprus, a data haven for all things grey area from porn tube sites to money laundering, was on the verge of financial collapse this spring and investors looked for a way out. Many didn’t want their filthy lucre to go legit, so they parked it in Bitcoin looking to ride out the storm.

That was the “original sin”. With Bitcoin’s newfound attention, casual investors took a hard look at Bitcoin as an investment vehicle. This casual investment allowed the cryptocurrencies’ value to maintain its record highs, as wealth was being transferred into the Bitcoin economy, despite its marginal utility value (the principles of the Bitcoin economy are unknown to most and the goods it can be exchanged for are limited).

Since then Bitcoin has been a roller coaster ride for all involved, slumping to $100 in mid-April, then back up to $140 by the end of the month. By mid-July it was down to $80 as news of increased regulation hit investors along with uncertainty of the future of a number of major exchanges.

As the chart below demonstrates, Bitcoin’s trade volume has seen the chilling effect of a future of doubt for a currency that is anonymous. Late July-early August were some of the lowest volumes on record for trades.

Time and time again market data shows that Bitcoin is primarily used at the drugs bazaar of Silkroad and to gamble. Both these activities rely on a veil of anonymity, thus when the veil is lifted the cryptocurrency will not be of much use to its primary users.

Though its diehard fans won’t admit it, Bitcoin’s future is limited. A currency is only as good as the stuff it can be exchanged for, thus if “know your customer laws” remove the ability for users to gamble or buy drugs anonymously with Bitcoin its value will plummet as users find another way to transmit value anonymously.